When you’re at the point in your home buying journey and are reviewing different mortgage loan options, the type of interest rate will play a big part in your final decision. Mortgage loans come in fixed and variable interest rate types.
What is an Interest Rate?
Before we get into the differences between fixed and variable interest rates, let’s talk about what an interest rate is related to mortgages. Unless you pay for your home cash in full, you’ll take out a mortgage loan to pay for the rest after your down payment. This mortgage loan comes with an interest rate, much like a credit card.
Fixed Mortgage Rates
With a fixed rate mortgage, your interest rate remains the same throughout the entire term of your mortgage. You’ll establish this rate with your lender when you initially apply for and process your mortgage loan. A fixed rate mortgage results in the exact same payment each month.
Variable Mortgage Rates
Variable mortgage rates are linked directly to federal mortgage rates (if rates fluctuate throughout the year). If national interest rates fall during your mortgage term, so will your mortgage interest rate. You’ll still pay the same amount each month, but the difference will be applied to your principal. When the interest rate goes up, more of each monthly payment goes toward interest; when rates go down, more of each payment goes towards your principal.
Pros & Cons of Fixed Mortgage Rates
● Consistency: You know exactly what you’ll be paying each month, which can provide financial stability and peace of mind. You’ll also know exactly how much of your monthly payment goes towards interest and principal.
● May be higher: Fixed rate mortgages can be higher than variable rate mortgages when you apply and get approved.
● Potential higher costs over time: If national interest rates drop, a variable mortgage will adjust accordingly. But your fixed rate mortgage will not and may ultimately be more expensive than a variable rate mortgage.
Pros & Cons of Variable Mortgage Rates
● Potentially lower costs over time: If interest rates remain the same or fall throughout the course of your mortgage, your mortgage interest rate will also fall, and more of your monthly payment will go toward your principal, resulting in paying off your mortgage faster.
● Less Predictable: Since we can’t predict housing market activity and mortgage rates, it’s impossible to know if interest rates will rise or fall over a mortgage term so there’s more risk involved in a variable mortgage rate, especially in turbulent economic times.
In the end, you’ll need to decide what is most comfortable for you. Knowing where your monthly payments are going may give you peace of mind and stability. If you have a fixed mortgage, you might feel discouraged if interest rates drop and you're not taking advantage of the market. If you’re on the fence, or want to discuss these options more in-depth, contact us to get connected with one of our dedicated, licensed loan officers!